To find a multi-bagger stock, what are the underlying trends we should look for in a business? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Although, when we looked at Guangzhou Kingmed Diagnostics Group (SHSE:603882), it didn't seem to tick all of these boxes.
What Is Return On Capital Employed (ROCE)?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Guangzhou Kingmed Diagnostics Group:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.069 = CN¥640m ÷ (CN¥12b - CN¥2.9b) (Based on the trailing twelve months to September 2023).
So, Guangzhou Kingmed Diagnostics Group has an ROCE of 6.9%. In absolute terms, that's a low return and it also under-performs the Healthcare industry average of 11%.
In the above chart we have measured Guangzhou Kingmed Diagnostics Group's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free analyst report for Guangzhou Kingmed Diagnostics Group .
The Trend Of ROCE
In terms of Guangzhou Kingmed Diagnostics Group's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 11%, but since then they've fallen to 6.9%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.
On a side note, Guangzhou Kingmed Diagnostics Group has done well to pay down its current liabilities to 24% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.
The Bottom Line On Guangzhou Kingmed Diagnostics Group's ROCE
We're a bit apprehensive about Guangzhou Kingmed Diagnostics Group because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Since the stock has skyrocketed 144% over the last five years, it looks like investors have high expectations of the stock. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.
One final note, you should learn about the 2 warning signs we've spotted with Guangzhou Kingmed Diagnostics Group (including 1 which doesn't sit too well with us) .
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.